Historical perspective and environmental cost—benefit analysis: comment on Doeleman

672

Rejoinder Historical perspective cost-benefit analysis: David

Pearce

In a recent

paper

Doeleman’

in this journal,

has suggested

cost-beneht

analysis

‘mistaken environmental control

and

optimization argues,

by

so

on. only

as

level, “zoning

population

This

relates in nature

resource

macroenvironmental set.

‘micro’

set out

such

CBA

and

his

decisions

in Doeleman’s conditions serious

may

for

a

liveable

one and deserves

wider

society

CBA

is

a

comment.

arises

that

there

is nothing

critique

of CBA,

mean

although

repetition

is

unwelcome;

ingredients

of

an

macro’

approach

further

development

(a)

new in Doeleman’s

that

caveats

indicate this does

of

integrated already

not

important

(b) exist,

is needed;

that

ment London,

Pearce of

is Professor

Political Gower

of Economics,

Economy, Street,

London

University WClE

to

preferences

have

ie those

the

changed

CBA

through rate

being

taken

of

rate.

If

is ‘high’

the

the preferences

those

t +n from the standpoint at time t. Nonetheless,

to reappraise (the at

example

to

and

favour

stock

of

declines.

The

end

‘creeping

development’.

result

of using

6BT,

UK.

Page4 restated within

in which

work

the objective

to include which

known. the

assets

CBA

well to

of

to solve resources

Doeleman of

Talbot

of society

a conservation

standard

t +n

is a form

are,

refers

uses)

development,

and

however,

if the

at

environmental

problems

of the

Doeleman

more

is of

use of natural

t + n, then the generation

is likely the

the

use of natural

College

effect

to downgrade

arises

the

the discount

for the optimal

Depart-

with

generation-

though (c)

through

severely at

at

t +n

In its non-

works

at time t-account

discount

The

‘micro-

at time

of the current

the future

failure

solution

forces.

form,

preferences

resource

This

efficient

for

a proper

in

time”.” any

that ‘static

provide

t, say, is not efficient

when

is for

meaning

development

because

himself David

fails

over

habitats below

has

environ-

proposition

and of

option comments

CBA of

so as to solve

efficiency,

direction

the

Comment brief

basic

operates

generation

The

criti-

is not an

issues.

paternalistic

of a

breach

how

context

‘macroenvironmental’

will,

(indeed,

argument)

of

at a

level and that the summation

set of micro

way

which

of

the

Doeleman’s

time

basic

operates

mental

allocation

targets

Nonetheless, that

in

“dynamic

parks,

a theory

statement

efficiency’

Unfortunately,

does

point,

to

quotas

Doeleman be

which

as

how

negative

with

standards

and

not

he

CBA

in some

of CBA

Nothing new

mistaken

be corrected,

targets”.2

such

the

analysis’

ceilings,

to

as

sets environmental

pollution

are

advanced

supplementing

a broad

things

accurate

to

pollution

has

a caricature

in

such

‘macroenvironmental effectively

Doeleman

cized

applied

wilderness,

can

that

will result

when

issues of

Jacobus

that the use of

(CBA)

optimality’

preservation

on

and environmental comment on Doeleman

efficiency

is

target objec-

FUTURES December 1985

Rejoin&r-historical

tives are then pursued. That is, a set 01 boundaries are drawn round the project appraisal techniques and the techniques have then to operate within those constraints. The constraints are generally the same as those set out, rather vaguely, by Doeleman and, indeed, they are not precise in Page’s own work. Thus, Doeleman’s paper adds little in this general philosophical respect to Page’s 1977 work. In fact, however, there is even earlier work by this author which sets out the same problem in the context of pollution control. Pearce5 argued in 1976 that CBA will result in an inefficient solution to pollution problems as long as the objective of society is established so as to include some measure of survival capability. The basic idea is simple. CBA operates in the sphere of human values as expressed through actual or surrogate markets. Unless those preferences are based on a very ‘long view’ they wilt tend to ignore the relationship between the optimization of preferences viewed from the standpoint of the beginning of some time period, and the ecological requirements for long term survival.6 In terms of the current environmental fashion, Pearce was arguing that economic optimization in the CBA sense would not necessarily coincide with the ecological conditions for sustainability of society. In terms of pollution, those conditions require that waste should not be emitted to the environment in quantities greater than the assimilative capacity of the environment. The analogue for renewable resources is that harvest rates should not exceed natural or managed yields. Pearce’s 1976 work deliberately excluded the discount rate from the analysis, whereas Page’s work is very largely concerned with the effects of discount rates. We return to the discount rate below. For the moment, we observe the first proposition: Doeleman has not produced a statement which cannot be found in Page’s 1977 work, to which he refers, or Pearce’s 1976 work, to which he does not refer.

FUTURES December 1995

perspective and envimmenlal

cost-benefit analyris

673

New rules The rules required for the incorporation ‘macroenvironmental’ of considerations, or what we regard as ecological constraints, into CBA can be indicated. The basic requirement is sustainability, which we take to mean (i) conditions for the survival of mankind, and (ii) conditions for the tolerable survival of mankind. The latter, we argue, includes maintaining such things as genetic diversity as insurance against uncertainty, and environmental services for which mankind demonstrates either an explicit willingness to pay, or an option to pay (option value), or an intrinsic valuation of the environment in itselfexistence value. We may also add the value attributed by individuals to an asset for its purpose as a bequest to future generations-bequest value. All these concepts are well established in the literature, and there are attempts to measure them. 7 Prior conditions for tolerable survival are readily stated for the ‘renewable’ elements of the environment. As noted above, waste emissions must be less than the degrader capacity of the environment, and harvest rates must be less than or equal to yield rates. These are the essentials of ‘biological equilibrium’, although neither determines the optimal stock of environmental assets (yields will often be stock-dependent), a subject we cannot develop in a short set of comments. Pearce, in a later paper, suggests that we can actually formulate pricing rules which accommodate the sustainability criteria.8 nonFor renewable resources the issue is different since any harvest rate reduces the stock, whether we think of stocks of blue whales or the stock of environment for wastes that have no counterpart degrader capacity in the environment (mercury, cadmium etc). In this context we have to resort to some concept of intergenerational fairness, which is how Page deals with it, or to a set of generic rules that basically ‘forbid’ irreversible activities,

or to amended CBA rules which do allow us to treat irreversibility in a more sophisticated way. The straw man of CBA The last point we make is that Do&man has an outmoded conception of CBA. Although he refers to some of the recent literature he has not absorbed one of its central messages. (Indeed, Doeleman greatly exaggerates even the practical use of CBA. In the UK it is a rarity, not the norm for decision aids.) First, what partly troubles him is that CBA incorporates a discount rate greater than zero. Indeed, he seems to think that CBA somehow logically entails ‘high’ discount rates, perhaps approximating market rates of interest. Yet this is true if, and only if, one takes a particular view of how to derive discount rates-ie by looking at the marginal productivity of capital-although even then it is not evident that even this approach dictates high real rates of discount. Even if it did, there is nothing in the logic of CBA that observation of such rates. requires Observation of normative rates based on social preferences could readily give rise to very low rates. Rates based on social time preference, for example, typically contain two components such that the social discount rate equals the sum of some measure of ‘impatience’ (the pure time preference rate) and the rate of of consumption. of utility growth Arguments about the ethical relevance of the former are well known. The latter can readily produce very low rates if economic growth prospects are poor, and will produce very low rates in many developing countries. The essential point is that CBA does not logically entail my particular discount rate. However, even if we adopt what Doeleman believes to be conventional and ‘high’ discount rates, does CBA necessarily dictate ‘creeping development’? Here it is slightly surprising that Doeleman has missed the message of the work of Krutilla and Fisher to which he refers,” perhaps because he has not

pursued the development of that work since 1975. The point of this work is that the decision to develop or conserve, using CBA, will not result in a compromise of some development and same conservation. Yet Doeleman’s whole analysis is based on the assum~t~an that compromise is the outcome of CBA-eg in his land use example . . . “C/B economics presents a set of recommendations, predictably amounting to aform of compromise . . “.* Yet the KrutillaFisher algorithms are quite clear in that, while they could result in some development and some preservation, the phenomenon of i~eoers~b~lity whereby development precludes anyone ever securing the benefits of preservation is highly likely to dictate corner solutions in which development is postponed altogether. Indeed, the conditions for this result to converge to a result in which development is neuer permitted, are set out by Porter in an excellent exposition and extension of Krutilla and Fisher’s work.” The mechanism at work is very much one in which delay increases the value of information about the benefits of preservation, Moreover, the preference system is biased in favour of preservation and against development. Doeleman notes the latter for developed countries but argues it is not likely to occur in developing countries, Yet even here he is issuing warnings which are well known. Much of what is happening in the Sahel, for example, has risen from a failure to recognize the requirements for biological equiiibrium.i2 That failure has nothing to do with CBA: forest clearance for agriculture in the Sahel or in Brazil, for example, has not been justified on CBA grounds but on grounds of macroeconomic ob_jectives which reveal limited or non-existent understanding of the ecological requirements for survival. In short, the sustainability criteria have not been met and the experience of these countries shows just how quickly the ill-effects of non-observance of the constraints arise. But this brings us full

FUTURES December 1985

Rejoinder-hisforicai

circle to Doeleman’s central point. Essentially, he is correct, but not new, not sufficiently constructive, and certainly unfair to CBA. References 1. J Doeleman, “Historical perspective cost-benefit and environmental analysis”, Futures, 17 (2), April 1985, pages 149-163. 2. Ibid, page 161. 3. Ibid, page 152. 4. T. Page, Conservation and Economic Efficiency (Baltimore, Johns Hopkins University Press, 1977). “The limits of cost5. D. W. Pearce, benefit analysis as a guide to environmental policy”, Kyklos, 29, Fast 1, 1976. 6. That myopia results in inefficient longrun welfare maximization reprdless of any ecological implications is well known in the economics literature. See R. Strotz, “Myopia and inconsistency in dynamic utility maximization”, Review of Economic Studies, 23, 1955-1956. R. Bishop, “Option 7. See for example, value: an exposition and extension”, Land Economics, 58, February 1982 8. D. W. Pearce, “Optimal prices for sustainable environments”, mimeo, University College, London, 1985. Krutilla and A. C. Fisher, 9. J. The Economics of Natural Environments (Baltimore, Johns Hopkins University Press, 1975). For a more recent statement see A. C. Fisher and J. Krutilla, “The economic theory of nature preservation”, in A. V. Kneese and J, L. Sweeney, Handbook of Natural Resource and Energy Economics, North-Holland, Amsterdam, forthcoming. 10. Doeleman, op tit, page 155. 11. R. Porter, “The new approach to wilderness preservation through benefit-cost analysis”, Journal of Environmental Economics and Management, 9, 1982. 12. See D. W. Pearce and A. Markandya, “Natural resource depletion in developing countries”, University College London, mimeo, 1985.

The author

replies

Pearce’s postscript “Historical perspective and environmental cost-benefit

FUTURES December 1985

perspective and cnvironmmtal cost-bcncjif analysis

675

analysis: comment on Doeleman” * indicates a measure of agreement on both the relevance and validity of the proposition that economic optimization per se would not necessarily coincide with the ecological conditions for sustainability of society. There is less agreement when Pearce claims that there is nothing new in this insight and that, indeed, hefollowed by others-has said as much in 1976.* He also argues that an interpretation of cost-benefit analysis (CBA) which emphasizes a microeconomic approach coupled with high rates of discount, does not do justice to recent developments in the technique. In reaching this conclusion, however, the position I have taken3 would appear to have been distorted. In his first paragraph, Pearce sets out that: Doeleman has suggested that the use of CBA will result in ‘mistaken optimality’ when apphed to environmental issues such as the preservation of wilderness, pollution control and so on. This mistaken optimisation can only be corrected, he argues, by supplementing CBA with ‘macroenvironmental analysis’ which effectively sets environmental standards on a broad level, and relates to such things as zoning as in nature parks, pollution ceilings, resource quotas and population targets (my emphasis). Two

corrections

and contrary

are in order to the above,

here.

I have

First, stated:

What is being argued here is based on the possibility of environmental standards eroding and not the necessity of this happening. In other words, the paradigm rest on inductive observation of what is happening rather than on deductive analysis of what must happen.

Historical evidence strongly points towards ‘mistaken optimality’ on account of a deterioration of environmental optima during this century. Of late, the media debate on the dying of the Black Forest in FR Germany as well as the most recent OECD pollution projections to the year 20004 reinforce this assessment. Second, in summing up my position, Pearce claims that I have argued that

676

Rejoinder-historical perspectiveand anvironmenfalcast-bene@ analysis

only so called macroenvironmental standards can offer correction. This is not so. Macroenvironmental standards are presented not as the only(!) but as the favoured solution. The difference allows Pearce to take issue with my supposedly having neglected what is, it would seem, his favoured solution: namely, to expand -as in literature quoted by him and myself-a narrow pragmatic microapproach to CBA by such methods as the incorporation of wider constraints; the measurement of option values in order to assess the consequences of irreversible actions; the employment of low or zero rates of discount, and so on. Indeed, one might be led to believe that I am opposed to the application and further development of CBA. academic In spite of worthwhile refinements in the theory, sight should not be lost of the political reality of the formal and widespread informal practice of CBA. Precisely for this reason I have sought to put the use of CBA in a historical perspective. Perhaps, therefore, Professor Pearce’s interest in CBA is more analytical, whereas mine is more political. For instance, Pearce writes that: He (Doeleman)

seems to think that CBA

somehow logically entails rates, perhaps approximating interest.

‘high’ discount market rates of

Of course, it goes without saying that one cannot rule out low or zero or, for that matter, negative discount rates on logical grounds. But my grounds are historical. One may observe how high discount rates (from an environmental point of view) have prevailed in CBA as they have in business and in political calculations. Furthermore, I have tried to argue why, ceteris @bus, this is likely to continue to be the case in the future. Finally, Pearce regrets that “Doeleman does not set out a theory of how such macroenvironmental targets are to be set”. A tall order. On the other hand, I have endeavoured to outline a number

of pertinent features of a preferred These policy. macroenvironmental features include the basis of such a policy in the decisions of ‘wise men and women’; the possibility of consistency with decentralized market or laissez-faire the conceivably pluralistic principles; nature of the policy’s effects; the scope for gradualism; and the vital need for protection against unqualified majority opinion. To my mind, the formulation of macroenvironmental targets is not so much a matter of theoretical deduction (as Pearce is seeking) but one of ethical choices in the interests of generations to come. Whether or not all this amounts to “nothing new” seems to be of limited Important is the warning consequence. that, by itself, pragmatic CBA can and does lead to wholly inadequate environmental decision making in the long run without there being sufficient awareness of this danger within or beyond the economics profession. It may be that to deal with this potentially disastrous inadequacy in environmental decision are changes institutions making, required which involve the incorporation of quantitative and qualitative environmental standards or safeguards in the constitution of countries with the wish to so approach a voluntary future.

References “Historical perspective and environmental cost-benefit analysis: comment on Doeleman”, above. D. W. Pearce, “~helimitsofcost-ben~~t analysis as a guide to environmental policy”, Kyklos, 29(l), 1976. J. A. Doeleman, “Historical perspective cost-benefit environmental and analysis”, Futures, 17 (Z), April 1985. Organisation of Economic Cooperation and Development, Second EnvironmentaE Report to the ~~v~~on~~t Ministers Countries, June 1985.

ofMember

Ja~obus Doeleman University of NCWLXZ& NSW

2308,

Australia

FUTURES December 1985